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Management Accounting
SESSION 4
Study Methodology & Class Discipline

• Ensure you attend class with A PEN, A NOTEBOOK AND A CALCULATOR.

• At IBA we follow Blended Learning Methodology, we will make use of online
resources available like videos, MOOCs, etc as a part of our learning.
• Concepts will be thoroughly explained. If you have any questions, please do not
hesitate to ask.
• Some numerical problems may be solved in the class but the responsibility of
attempting remaining exercises and problems rests with the students
• In Accounting, PRACTICE is essential to gauge the concepts clearly.
• You will NOT be allowed to use phones and/or laptops during the class.
• Attendance can be taken at anytime during the class.
• You are NOT allowed to leave the class after the attendance has been taken.
FINANCIAL ACCOUNTING vs MANAGEMENT
ACCOUNTING
FINANCIAL ACCOUNTS
• Financial accounts detail the
performance of an organisation
over a defined period and the
state of affairs at the end of that
period.
• Limited liability companies must,
by law, prepare financial accounts.
• The format of published financial
accounts is determined by local
law, by International Accounting
Standards and International
Financial Reporting Standards. In
principle the accounts of different
organisations can therefore be
easily compared.
MANAGEMENT ACCOUNTS
• Management accounts are used to
aid management record, plan and
control the organisation's activities
and to help the decision making
process.
• There is no legal requirement to
prepare management accounts.
• The format of management
accounts is entirely at
management discretion: no strict
rules govern the way they are
prepared or presented. Each
organisation can devise its own
management accounting system
and format of reports.
FINANCIAL ACCOUNTING vs MANAGEMENT
ACCOUNTING
FINANCIAL ACCOUNTS
• Financial accounts concentrate on
the business as a whole,
aggregating revenues and costs
from different operations, and are
an end in themselves.
• Most financial accounting
information is of a monetary
nature.
• Financial accounts present an
essentially historic picture of past
operations.
MANAGEMENT ACCOUNTS
• Management accounts can focus
on specific areas of an
organisation's activities.
Information may be produced to
aid a decision rather than to be an
end product of a decision.
• Management accounts incorporate
non-monetary measures.
Management may need to know,
for example, tons of aluminium
produced, monthly machine
hours, or miles travelled by
salespeople.
• Management accounts are both a
historical record and a future
planning tool.
Three Major types of Businesses

1) Manufacturing

2) Trading

3) Service Industry
COST CLASSIFICATION

The total cost of making a product or providing a service consists of the

following.

(a) Cost of materials

(b) Cost of the wages and salaries (labour costs)
(c) Cost of other expenses also known as overheads
• Rent and rates
• Electricity and gas bills
• Depreciation
Direct Costs & Indirect Costs

• A direct cost is a cost that can be traced in full to the product,

service or department that is being costed.
• An indirect cost (or overhead) is a cost that is incurred in the
course of making a product, providing a service or running a
department, but which cannot be traced directly and in full to the
product, service or department.
Direct Costs & Indirect Costs
Materials, labour costs and other expenses can be classified as either direct
costs or indirect costs.
(a) Direct material costs (DM) are the costs of materials that are known to
have been used in making and selling a product (or even providing a
service). Direct material is all material becoming part of the product.
(b) Direct labour costs (DL) are the specific costs of the workforce used to
make a product or provide a service. These are the costs of labor that can be
directly traced to the production of a unit. Direct labour costs are
established by measuring the time taken for a job, or the time taken in
'direct production work'.
(c) Direct expenses (DE) are any expenses which are incurred on a specific
product other than direct material cost and direct wages. Expenses that
have been incurred in full as a direct consequence of making a product, or
providing a service, or running a department.
Direct Costs & Indirect Costs
Indirect material (IM)
Indirect materials are materials that are not the main components of
the finished goods. Indirect labour

Indirect labour (IL)

Indirect labour is part of the overall production process but doesn’t
come into direct contact with the product.

Indirect expenses (IE)

Indirect expenses are general expenses which are not directly related
to the product or service
Direct Costs & Indirect Costs
• A direct cost is a cost that can be traced in full to the product, service or
department that is being costed
• Direct costs are made up of direct materials, direct labour and direct
expenses
• Total direct costs are known as prime cost
• An indirect cost is a cost which cannot be traced directly to the product,
service or department
• Indirect costs are also known as overheads
• Examples are indirect materials, indirect labour, indirect expenses,
administration overhead, selling/distribution overhead
• Costs can also be classified according to their function
• Examples will be production costs, administration costs, marketing or
selling and distribution costs
Direct Costs & Indirect Costs
• There are also other ways in which costs can be classified
• These might include discretionary costs, avoidable/unavoidable costs,
controllable/non-controllable costs
• Product costs are costs identified with a finished product and are
part of the inventory value
• When the goods are sold these costs become expenses (cost of goods
sold)
• Non-product or period costs are costs that are deducted as expenses
during a period
• Period costs are never part of the inventory value.
Direct Costs & Indirect Costs

Total Costs Direct Costs Indirect Costs

• Materials • Direct • Indirect
• Labour Materials Materials
• Expenses • Direct Labour • Indirect Labour
• Direct • Indirect
Expenses Expenses
Identify Direct & Indirect Costs - Question
Fixed Costs and Variable Costs

A different way of analysing and classifying costs is into fixed costs and
variable costs.
A fixed cost is a cost which is incurred for a particular period of time and
which, within certain activity levels, is unaffected by changes in the level of
activity.
A variable cost is a cost which tends to vary with the level of activity.
A semi-variable cost, also known as a semi-fixed cost or a mixed cost, is
a cost composed of a mixture of fixed and variable components. Costs are
fixed for a set level of production or consumption and become variable after
this production level is exceeded. If no production occurs, a fixed cost is still
incurred.
Fixed Costs and Variable Costs

Examples of fixed and variable costs

(a) Direct material costs are variable costs because they rise as more
units of a product are manufactured.
(b) Sales commission is often a fixed percentage of sales turnover, and so
is a variable cost that varies with the level of sales.
(c) Telephone call charges are likely to increase if the volume of business
expands, but there is also a fixed element of line rental, and so they are a
semi-fixed or semi-variable or mixed overhead cost.
(d) The rental cost of business premises is a constant amount, at least
within a stated time period, and so it is a fixed cost.
Question:

A business has the following costs for a period.

Materials Rs. 600,000
Labour Rs. 1,000,000
Production overheads Rs. 500,000
Administration overheads (rental, security, insurance)Rs. 700,000
During the period 1000 units are produced and 800 units are sold at Rs. 4000 each.

Requirement:
What is the direct cost per unit?
What is the total cost per unit?
What is the gross profit for the period?
What is the net profit for the period?
Solution:
Materials Rs. 600,000
Labour Rs. 1,000,000
Total Direct Cost Rs. 1,600,000
Production Overhead Rs. 500,000
Total Production Costs Rs. 2,100,000
Number of units 1000
Direct Cost per unit Rs. 1,600
Total Cost per unit Rs. 2,100

Sales (800 x 4000) Rs. 3,200,000

Cost of sales (800 x 2,100) Rs. (1,680,000)
Gross profit Rs. 1,520,000
Administration
overheads Rs. (700,000)
Net Profit Rs. 820,000
Cost Behavior Patterns & Cost per unit

Exel Ltd. Produces product A.

The variable cost of producing product A is Rs. 50.
Fixed Costs are Rs. 50,000.

Requirement:
At the following different levels of production of the product A.
1 Unit 100 Units 250 Units

Calculate total cost .

Calculate fixed cost per unit.
Calculate total cost per unit.
Cost Behavior Patterns & Cost per unit

SOLUTION:
Production Units 1 100 250
Variable cost (Rs.) 50 50 50
Total Variable cost (Rs.) 50 5000 12,500
Fixed Costs (Rs.) 50,000 50,000 50,000
Total Costs (Fixed+Variable) (Rs.) 50,050 55,000 62,500
Fixed Cost per unit 50,000 500 200
Total cost per unit (Rs.) 50,050 550 250

What happens when activity levels rise can be summarised as follows.

 The variable cost per unit remains constant.
 The fixed cost per unit falls.
 The total cost per unit falls.
Product Costs Versus Period Costs

Product costs include direct Period costs include all selling

materials, direct labor, and costs and administrative
manufacturing overhead. costs.

Inventory Cost of Good Sold Expense

Sale

Balance Income Income

Sheet Statement Statement
Cost Behaviour

Cost behaviour is the way in which costs are affected by changes in the
volume of output.
Management decisions will often be based on how costs and revenues
vary at different activity levels.
Examples of such decisions are as follows.
 What should the planned activity level be for the next period?
 Should the selling price be reduced in order to sell more units?
 Should a particular component be manufactured internally or bought
in?
 Should a contract be undertaken?
 Question – Determine per annum total costs
Deinfa has a fleet of company cars for sales representatives. Running costs have been estimated as follows.
(a) Cars cost Rs.1,200,000 when new, and have a guaranteed trade-in value of Rs.600,000 at the end of two
years. Depreciation is charged on a straight-line basis.
(b) Petrol and oil cost Rs.15 per mile.
(c) Tyres cost Rs. 30,000 per set to replace; replacement occurs after 30,000 miles.
(d) Routine maintenance costs Rs. 20,000 per car (on average) in the first year and $45000 in the second year.
(e) Repairs average Rs. 40,000 per car over two years and are thought to vary with mileage. The average car
travels 25,000 miles per annum.
(f) Tax, insurance, membership of motoring organisations and so on cost Rs. 40,000 per annum per car.
Requirement
• Calculate the cost of cars which travel 15,000 miles per annum and 30,000 miles per annum for year 1 and
year 2.
• Calculate the average cost of cars which 15,000 miles per annum and 30,000 miles per annum for 2 years.
Solution – Determine per annum total costs

15,000 Miles 30,000 Miles

Y1 Y2 Y1+Y2 Y1 Y2 Y1+Y2

Dep 300,000 300,000 300,000 300,000

Petrol 225,000 225,000 450,000 450,000
Tyre Replacement - - - 30,000
Maintenance 20,000 45,000 20,000 45,000
Repairs 12,000 12,000 24,000 24,000
Tax 40,000 40,000 40,000 40,000

597,000 622,000 1,219,000 834,000 889,000 1,723,000

Average Cost per annum 609,500 861,500
Determining the fixed & variable elements of
semi-variable costs by High-low method

Cost accountants tend to separate semi-variable costs into their variable and
fixed elements.

variable cost / unit = Total cost* at high activity level - total cost* at low activity
Total units at high activity level - total units at low activity

The fixed part of the mixed cost can be determined as follows

Fixed Costs = Total Cost at an activity level – (Units at activity level x Variable
cost/unit)
*Total cost excludes the step-fixed cost component
The high-low method

QUESTION:
Dynamic Ltd. has recorded the following total costs during the last five years.
Year Output volume Total cost
Units $
2013 65,000 145,000
2014 80,000 160,000
2015 90,000 170,000
2016 60,000 140,000
2017 75,000 155,000

Requirement:
Calculate the total cost that should be expected in 2018 if output is 85,000 units.
The high-low method

QUESTION:
The Washington Company incurred Rs. 50,000 to ship 22,000 liters
and Rs. 42,000 to ship 18,000 liters.

Requirement:
Calculate the expected shipping expense if the company ships
20,000 liters.
The high-low method

QUESTION:
ABC Co has a manufacturing capacity of 10,000 units. The flexed
production cost budget of the company is as follows:
Capacity 60% 100%
Total production costs (Rs.) 11,280 15,120

Requirement:
What is the budgeted total production cost if the company operates
at 85% capacity?
High-low method with stepped fixed costs

QUESTION:
The following data relate to the overhead expenditure of contract cleaners (for
industrial cleaning) at two activity levels.
Square metres cleaned 12,750 15,100
Overheads $73,950 $83,585

When more than 14,000 square metres are industrially cleaned, there will be a
step up in fixed costs of $4,700.
Requirement:
Calculate the estimated total cost if 14,500 square metres are to be
industrially cleaned.
The high-low method
QUESTION:
An organisation has the following total costs at two activity levels:
Units Cost (Rs)
15,000 380,000
24,000 470,000

Variable cost per unit is constant in this activity range but there is a
step up cost of Rs. 18,000 when the activity exceeds 20,000 units.
Requirement:
What are the total costs at an activity level of 18,000 units?
 The high-low method
QUESTION:
V Ltd buys IT support services from an outside agency. In its last four accounting periods, the
charges made by the agency have been as follows:
Period Usage Charge for services
(hours) Rs.
1 3,700 16,700
2 4,900 20,300
3 3,250 15,350
4 5,800 23,000
 
The agency did not increase its charging rates in periods 1 to 4. It has notified V Ltd that, in
period 5, it will increase the fixed element of the charge by 5% and the variable element by
10%.
If V Ltd estimates its level of usage at 5,500 hours in period 5, what will be the expected
charge for IT support services?
 The high-low method
QUESTION:
An organisation has the following total costs at three activity levels:

Activity level (units) 8,000 12,000 15,000

Total cost (Rs.) 204,000 250,000 274,000
 
Variable cost per unit is constant within this activity range and there is a step up
cost 10% of fixed costs when the activity level exceeds 11,000 units.
Requirement:
What is the total cost at an activity level of 10,000 units?